1740H Dell Range Blvd.

, #300 I Cheyenne, Wyoming 82009

PHONE: 307.433.8180 I FAX: 307.634.9497
EMAIL: info@bisimplified.com

www. b isimp lifie d . co m

ARTICLES: THE 411

Business Income Insurance Policy: End the Confusion

Guide to ISO Business Income and Extra Expense Coverage Form
By Robert M. Swift, CPCU, CIPA, CBCP

Since the Insurance Services Office (ISO) wording is the about the author
most widely used contract language, this article will discuss Robert M. Swift, CPCU, CIPA, CBCP
the various components of this type of insurance policy. As a is a business
rule, business owners do not read their policy until they have interruption
a claim and then it is too late. They are surprised to discover specialist with
exclusions, missing coverages, and incorrect limits. Therefore, more than thirty
it is important for agents to emphasize that insurance buyers years’ experience
worldwide in the
carefully read the entire insurance policy to determine their
insurance and risk management
rights and duties, as well as what is and is not covered. field. Swift assists insurance
The following areas of the insurance policy cause the most professionals with providing
confusion. market differentiation to their
clients through business income
consultations and appraisals.
RENTAL INCOME: May be included, excluded, or by itself. He also reviews insurance
This coverage protects income from a third party who has an contracts for coverage gaps, traps,
“arm’s length” relationship with the insured. For example, undervaluation, and missing
the jewelry counter or shoe department in a department protection and believes thorough
preparation is essential. Through
store is owned by another company and they lease space
his company, Business Interruption
from the store and pay a percentage of their sales as rent. Consultants, Inc., he has developed
If the department store burns down, the store loses this a unique, Web-based BI resource,
rental income. www.BISimplified.com that
Rents are an area of confusion because quite a few includes a detailed analysis of
the Commercial Property/Business
organizations have separate entities for their operations and
Income insurance policy.
realty ownership. For example, the president owns the real
Mr. Swift is an accredited instructor
estate and the operating company pays him rent through
for the Institute for Business
his realty company. This is simply two pockets of the same Continuity Training and is in
suit and not considered rent protection as long as both demand by numerous professional
entities are named insureds on the policy. The business organizations as a frequent public
income policy pays the rental expense as a continuing speaker. He is a member of the
expense of the operating company, so it does not have to CPCU Society, the Disaster Recovery
Institute, the Risk and Insurance
be included as additional income.
Management Society, the National
Society of Insurance Premium
Auditors, and a past member of
the Insurance Institute of London.

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 BUSINESS INCOME: Defined in the policy to be net profit or loss, plus continuing normal
operating expenses, including payroll.
For example: Sales minus cost of sales equals gross margin or gross profit for manufacturers,
wholesalers, and retailers and is approximately the 100% B.I. amount.
Net sales: $10,000,000
Cost of sales: - 7,000,000
Gross profit: $ 3,000,000 (approximate annual business income amount)
Service organizations do not have cost of sales, so their 100% BI amount is their annual revenues.

As a rule of thumb, combined BI and extra expenses should be approximately:

Manufacturers: 100% of their gross profit.
Wholesalers: 50% of their gross margin.
Retailers: 30% of their gross margin.
Service: 15% of their revenues.
Do not use the above chart to determine insurance limits, but it will help prioritize your accounts
so you are able to spend time on those needing the most attention.

ORDINARY PAYROLL: This causes a lot of problems. Businesses think it is direct labor, cash
labor, warehouse, or temporary help, so they exclude this coverage from their policy. However,
it is defined in the policy to be everyone below the department manager level. When this is
explained to the insured, their usual comment is that they cannot afford to lose these people
and want them included.
At the same time, if they do lay off employees after a disaster, their unemployment tax rate
could increase, there are less qualified people in the job pool when they recover, and they have
lost their reputation in the community. Following Hurricane Katrina, business owners discovered
after they had rebuilt their facilities and contacted their employees to come back to work, very
few returned because they had found other jobs. Consequently, these businesses folded because
they had no experienced employees to produce their product.

COMMON AREAS: If there is no physical damage to the premises, there is no business income
coverage. There have been several high rise office buildings damaged by fire, hurricanes,
tornadoes, etc., but because a specific suite was not damaged, their claim was denied even
though there was no access. The ISO policy includes common areas as part of the premises
definition, but many policies currently on the market do not. It should be part of the premises
description on the actual policy so that a tenant’s premises include all internal access routes
(hallways, stairs, elevators, etc.).

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 LAW AND ORDER: Remember to endorse “building ordinance” and “increased cost of
construction” because while waiting for the property to be repaired, you could be losing a
significant amount of sales.

DEDUCTIBLE: Most business income policies have a twenty-four to seventy-two hour

deductible for lost income with no deductible for extra expenses. Some policies define it to
be “normal business hours” which means a company working nine to five with a seventy-two
hour deductible would subtract nine days from their claim.

EXTRA EXPENSES: Do not confuse expediting expenses with extra expenses even though
some policies mistakenly call expediting expenses “extra expenses.” The difference is extra
expenses pay ALL the expenses above normal operating expenses incurred to recover from a
disaster. However, expediting expenses only pay the expenses that directly reduce lost income.
For example, extra expenses are all the necessary money spent to avoid or minimize the
suspension of business. $750,000 reduces the loss of $500,000, but it pays all $750,000.
Expediting expenses are the monies spent that actually reduce the loss. $750,000 spent reduces
the loss $500,000, so it only pays the $500,000, a very big difference.

CIVIL AUTHORITY: Access to premises denied by civil authority due to adjacent property
damage, commonly has a twenty-four to seventy-two hour deductible with coverage lasting
three weeks. There is no coverage for evacuation prior to the event, only for denied access after
the disaster strikes because it is the physical damage that triggers the coverage.
For example, three days prior to a hurricane, the city is evacuated. Three days after the hurricane
makes landfall, the access denial is lifted. However, your landlord denies you accessibility while
they check the building for damage. Three days later they say there is no damage and allows
entrance to your premises. What is the civil authority period of claim? The three days from
hurricane landfall to access denial lifted by the city, not the landlord. This causes a tremendous
amount of confusion for the insured and is even more reason for them to have a Contingency
Plan that includes conversations with the landlord about how quickly they will open the building
or find other space for them.

EXTENDED PERIOD OF INDEMNITY: Pays for lost sales after the business resumes operations.
There is an automatic extended period of indemnity of thirty days in most policies, but this may
not be enough to allow the business to reach their projected sales once they have resumed
operations. The business usually needs at least 90, 180, or even 360 days if there is seasonality
to the business. Once again, the Contingency Plan identifies this need for the business.

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 LOSS CONDITIONS: The area of the policy that explains the rights and responsibilities of the
insured regarding claim payment. To eliminate confusion, these conditions need to be reviewed
to make certain the business has the proper endorsements and they will be in compliance with
all the requirements at the time of a loss. Several of the most important ones are:

Loss Settlement Fees: If not already included, businesses should endorse their
policy with “claim preparation” or “loss settlement fees" wording and probably
need at least $25,000 to $100,000 to pay for an experienced consultant to help
calculate the loss.

Duties in the Event of Loss: Educates the insured so they know what to expect
and what their responsibilities are including how to submit their claim. A business
owner stated he lost $10 million because of the disaster, but when pressed he
was just submitting his policy limit.

Loss Determination: Excludes community-wide disaster impact. For example, a

hotel could have a 125% occupancy rate following an event because most of the
hotels in the city were destroyed, but their historical occupancy was 85%. Their
claim would be based upon the 85% number, not the 125%. They cannot make
money from the disaster.

Loss Payment Clause: This is very frustrating because the insureds misread this
statement. It states the insurance company will pay thirty days after reaching an
agreement on the amount of loss, NOT thirty days after claim submission.
Since even minor business income claims take a long time to come to agreement,
it is imperative that the insured have alternative financing available to supplement
their cash flow while they are working on their claim amount.

COINSURANCE: This really causes problems at the time of the claim and states that if the in-
sured’s business income limit is mathematically incorrect at the time of loss, then the insured
will pay that error percentage of the claim.
For example, the policy states there is a $1 million limit with a 50% coinsurance clause.
This means the 100% amount would be $2 million. If, at the time of loss, the 100% amount was
$3 million, then the limit should be $1.5 million (which is 50% of the $3 million). Therefore the
insured would be penalized 33% of their claim, and paid $1million versus $1.5 million.
One client was penalized 85% of their $750,000 loss because they had not revised their
insurance limits or coinsurance amounts in several years. The coinsurance penalty is responsible
for a lot of lawsuits and unpaid claims. If possible, endorse “agreed amount” on the policy and
eliminate this problem. However, to do so requires a signed BI worksheet in file showing future
projections of income. No worksheet, then coinsurance would apply.

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 Since most ISO companies have only filed rates to go down to fifty percent of the annual
amount or a six month coverage, there are two other options available for businesses that want
less than six month’s protection.

1. Maximum Period of Indemnity: Covers actual loss sustained for 120 days.
No coinsurance applies, but this pre-settles the loss period and will not pay
for a partial loss that exceeds 120 days.

2. Monthly Limit of Indemnity: A commonly used endorsement that provides

a chosen monthly percentage of the limit. 33% provides one third of the limit
for three months, 25% gives one fourth of the limit each month for four months,
etc. No coinsurance, but the problem is this endorsement also limits the loss
period and the amounts are not additive. In other words, use it or lose it.
For example, a $100,000 limit with a 33% monthly limit would be:
Month 1, lost $45,000 Policy pays $33,000
Month 2, lost $27,000 $27,000
Month 3, lost $38,000 $33,000
Total lost $110,000 Total paid $93,000

During a BI consultation, when I pointed out policy language that stated actual cash value
for property damage, the president of a large, multi-national company explained that the
underwriter told him not to worry; the insurance company would pay replacement cost. The
executive was betting tens of millions of dollars against the policy language. In summary, it
does not matter what someone says, it is the insurance contract language that dictates how the
claim will be paid. Businesses get into trouble with their claims because they have not read their
insurance policies and are not aware of their rights and duties, as well as what is and is not
covered. The time for clarification is before a disaster. End the confusion: Be prepared and be
protected.

1740H Dell Range Blvd., #300 I Cheyenne, Wyoming 82009

PHONE: 307.433.8180 I FAX: 307.634.9497
EMAIL: info@bisimplified.com

www. bisimplified .co m

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Copyright © 2008 Business Interruption Consultants, Inc.
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